Legal Aspects of Crowdfunding by Natalia Thurston, Social Venture Law

7/27/2019 Legal Aspects of Crowdfunding by Natalia Thurston, Social Venture Law

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CROWDFUNDING: LEGAL ASPECTSOF ALTERNATIVE FINANCE

Presented by Natalia Thurston, Social VentureLaw

55 Francisco St., Suite 403San Francisco, CA 94133Tel: [email protected]


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Background

Economic Climate

Focus on Small Business

Growth of Micro-Lending

Social Impact Investing

Federal Law: JOBS Act

SEC Regs (Title II)


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Alternative Investment Vehicles

Reward-Based

Entity offers gifts/rewards in exchange for funding

Kickstarter, Indiegogo

Peer-to-Peer Lending Loans from unrelated individuals to individual

borrowers with verifiable credit history

Lending Club, Prosper


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Alternative Investment Vehicles

Direct Public Offerings Entity raises capital without intermediary offering stock directly to

public

Requires state-level registration and exemption from SEC

regulations; compliance with state Blue Sky laws

Self-Directed IRAs Individual retirement funds are invested in assets such as real

estate, restaurants, promissory notes, tax lien certificates, and

private placement securities LLC Structured IRA

IRS regulations govern to prohibit self-dealing


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Securities Act of 1933

Section 5 prohibits use of mails or interstatecommerce for the direct or indirect sale of securitieswithout SEC registration.

Additional provisions in the Securities Act regulate

registration process, impose audited financialreporting, public disclosure requirements, and waitingperiods on marketing efforts.

Section 4(2) exempts from Securities Actrequirements transactions by an issuer not involving

any public offering. SECs Rule 146 prohibits general solicitation and

general advertising; issuers were required to pre-screen offerees and evaluate their financial conditionand sophistication. (1974)


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Securities Act of 1933

Reg D was promulgated in early 1980s to addressuncertain patchwork of exemptions

Reg D superseded Rule 146 and authorized the

SEC to exempt from registration offerings up to $5million

Private placements under Reg D avoid the fullburden ofthe Acts registration, disclosure &

reporting requirements

General solicitation and general advertising

continued to be prohibited without a least anunderlying state registration


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Regulation D

Rule 504 Rule 505 Rule 506Eligible

Transaction

s $1 Million maximum offering

Not available to reporting

(Public) companies or

investment companies

$5 Million maximum

offering No maximum offering

size

Eligible

Participants No limitation on the number of

purchasers No accreditation or

sophistication requirements

Limited to 35 purchasers

Certain purchasersincluding accredited

investors do not count

toward the purchaser limit

Limited to 35

purchasers Certain purchasers

including accredited

investors do not count

toward the purchaser

limit

Non-accredited

investors or their

representatives must

meet sophistication

standardsRequiremen

ts No affirmative disclosure

obligations (state securities

offering laws are thought to

provide the necessary

protections) Resale of securities is

Affirmative disclosure

obligations apply when

non-accredited investors

participate in the

transaction Resale of securities is

Affirmative disclosure

obligations apply when

non-accredited

investors participate in

the transaction Resale of securities is


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Reg D Limitations

Securities may not be resold except underlimited circumstances highlighting lack of liquid

secondary market for resale. General Solicitation is not allowed, a pre-

existing substantive relationship must exist.

Generally advisors pre-qualify would beinvestors before providing information on thesecurities and frequently use a waiting periodbefore investment.


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Reg D Applied

Online investment platform: Mosaic(https://joinmosiac.com) utilizes Reg Dexemption to provide loans to solar projects

Investors must either be residents of California orNew York; or they must be accredited investors orin some cases sophisticated non-accreditedinvestors

When a projects Note has reached its fundingcommitment, investors commitment amounts aretransferred to the project

Investors receive return on their notes frompayments made by the projects to Mosaic
https://joinmosiac.com/https://joinmosiac.com/


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Future Legal Landscape

SECs forthcoming regulations

JOBS Act directed SEC to produce regulationsallowing crowdfunding up to $1million per yearthrough broker dealer or newly created intermediaries

funding portals

Reporting/disclosure requirements for crowdfundingrules undetermined

JOBS Act instructs SEC to remove ban on generalsolicitation

SECs non-accredited investor solicitation investorrules due Dec 31, 2012; both accredited and non-accredited rules expected end of 2013


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SEC Title II Regulations

SECs adopts new rules lifting ban on general solicitation (July10, 2013) New SEC rules address Title II of the JOBS Act, creating a walled

garden for accredited investors.

New SEC rules address Dodd-FrankActs investor risk concerns andrestrictsfelons and other bad actors from participating in Reg D offerings

Allows equity-based crowdfunding intermediaries to promoteinvestment offerings to accredited investors using the Internet andsocial media (Ex: CircleUp, Mosaic, Crowdfunder.com)

Promotion must lead back to a platform that verifies accreditedinvestors before giving them access to the investment offering

Requires additional registrations with SEC

New rules regarding Title III unaccredited investors expected byend of 2013

Estimated U.S. market for Title II crowdfunding(accredited investors): $20 Billion (Source: CrowdFundBeat)

Estimated U.S. market for Title III crowdfunding (non-accredited investors): $2 Trillion (Source: CrowdFundBeat)


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Fiduciary Duties

Fiduciary duties of broker-dealers vs. investment advisors toinvestors.

Investment advisors (regulated by FINRA) owe a fiduciary obligationto their clients.

Broker dealers must recommend suitable investments but are not

generally assumed to owe a fiduciary standard. Distinction between advice/planning and merely facilitating the

transaction is lost on many investors.

A number of investors in failed Reg D offerings have filed suit againstbrokerages based on failure to conduct adequate due diligence.

Under the JOBS Act crowdfunding provisions, it is unclear whether

a fiduciary duty will be owed by broker-dealers or funding portals toinvestors.

Dodd Frank legislation gives authority to SEC to adopt a uniformfiduciary standard applicable to all giving investment advice.

Funding portals mayfall under the Uniform Fiduciary Standardalong with investment advisors and broker-dealers.


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Risks to Investors

Use of Internet and social media to marketofferings increases risk to investors of improperoffers to sell securities

Hack, Pump & Dump Schemes (spreading falseinformation on the Internet to inflate stock price)

Risks to investors of fraud will weaken capitalmarkets

No current marketplace for secondary exchangeof securities

Public scrutiny and transparency in reward-basedcrowdfunding


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Public Policy Issues

Regulatory burden too great?

Regulations defeat purpose of efficiency?

Case Study: Pabst BrewingCompany/BuyaBeerCompany.com

Two advertising executives created BuyaBeerCompany.com to raise

$300 million to purchase Pabst Brewing Company by collecting pledgesthrough their site, Facebook, and Twitter. Contributors would receive:

A crowdsourced certificate of ownership and Beer worth the value of their pledge

Collected pledges totaling $14.5 million in the first 3 weeks and morethan $200 million in the first four months.

SEC took the position that the arrangement constituted an offer to sellsecurities, triggering Section 5s registration requirement.

Ultimately the two agreed to a cease and desist order from the SEC. Pabst was later sold for an undisclosed amount, reportedly about $250

million.


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Questions/Discussion

Natalia Thurston

Social Venture Law

55 Francisco Street, Suite 403

San Francisco, CA 94133

Tel: (415) 240-9024

Email: [email protected]

Documents

Legal Aspects of Crowdfunding by Natalia Thurston, Social Venture Law